Dun & Bradstreet Corp

Dun & Bradstreet Corp

Overview

Dun & Bradstreet Corp (DNB, Financial) provides commercial data, decision and risk management analytics on businesses to help other businesses, lenders, advertising agencies and government institutions improve and streamline their decision making processes. Two of the best known examples of DNB's solutions include "D&B Risk Management Solutions" and "D&B Sales & Marketing Solutions." D&B Risk Management Solutions is an analytical system that provides estimates of business credit risk and helps lenders and insurers in the financial service industry assess the creditworthiness of potential borrowers. D&B Sales & Marketing Solutions is a database and analytical system that enhances the data management capabilities of marketing firms. All together, DNB has a global commercial database that contains more than 230 million business records. DNB gathers, transforms, and repackages commercial data into knowledge and analysis and then sells it to consumers to assist in their operating decisions.

Earnings Check-Up

About $1,655M in revenues moved through DNB's door in 2013. DNB’s revenues for the Dec 2004 to Dec 2013 period clocked in at an average annual rate of growth of 2%. Increased competition in the data analytics business have softened results over the last 3 years with revenues essentially remaining flat (growing at a annual rate of 0% over the last 3 years and -1% per year over the last 5 years). Year-over-year DNB continues to make substantial sums of money off revenues after subtracting costs of goods sold, with gross profits reaching $1,105M in 2013.

DNB's production costs could be more effectively controlled, with COGS rising by 4% per year over the last 10 years against revenue growth of 2%. This is making it difficult for the firm to protect gross margins, which have trended downwards from 71% in 2004 to 67% in 2013. It could also be a sign that the firm is experiencing greater difficulties passing on the cost of inflation to consumers. Nonetheless, average gross margins of 70% over the last 10 years is an exceptional result and indicative of a firm with a strong competitive advantage and relatively low cost operating position.

DNB spends about 35% of gross profits on hard costs associated with selling expenses, advertising, management salaries, payrolls, advertising and legal fees. We consider this an exceptional result. Cost of SG&A have also been on a downward trend. The primarily variable cost structure of the firm's operations has allowed management to decrease SG&A by 1% per year over the last 10 years and by 2% per year over the last 3 years. This is precisely what we want to see for a firm with flat revenue growth and signals management's commitment to controlling costs.

DNB has shown consistent strength in its operating earnings picture. The long-term trend in operating income has been upward and generally stable, rising from $319M in 2004 to $437M in 2013. DNB has earned on average about 26% in operating earnings on total revenues over the last 10 years--a fantastic result. DNB carries a moderate amount of debt on its books and, consequently, pays out 9% of operating income on interest payments annually.

Bottom line results show a soft upward long-term trend in earnings (fluctuating with the business cycle) growing at an average annual rate of 2% over the last 10 years. DNB has maintained net margins of about 16% over the last 3 year, 5 year, and 10 year periods. These margins are indicative of a firm that has been able to maintain a strong competitive advantage. Intensified competition, however, will make it difficult for DNB to further expand these margins.

DNB’s per share earnings story has been particularly strong. Diluted EPS grew from $2.90 per share in 2004 to $6.54 in 2013. EPS growth has been fuelled primarily by the company's heavy share repurchase activities. We like seeing that, since 2004, earnings growth has trended inline with revenue growth. We also like seeing that the firm's share-base has fallen by over 30M since 2004. With flat sales and a moderate uptick in earnings expected over the next few years, we are happy to see that management remains committed to rewarding shareholders.

DNB's return on equity is not meaningful. ROA, however, remains exceptional averaging 16% over the last 10 years and 14% over the last 3 years.

Purchase Considerations

DNB's databases and analytic solutions are sold to a variety of firms and service organizations, including banks, credit agencies, credit card companies, data security firms, insurers, telecom companies, retailers, government institutions, and health care providers among others. DNB's risk management products account for 63% of the firm's total revenues. DNB's sales and marketing products account for 37% of company revenues.

Business, consumer and risk management data and analytic systems are becoming increasingly important in an increasingly knowledge driven economy. DNB has made substantial progress at refining its systems, making them more accessible and user friendly for clients. This is in addition to efforts made to educate potential clients on how its information sources could be incorporated into their own systems and used effectively in their day-to-day operations, with the end goal of course of helping them boost revenues and lower costs. Many companies compete in DNB's product/service space, but few have a history and brand reputation of more than 150 years. The company's products/services are regarded by many as the best in the industry. The company has built a strong competitive advantage around its brand, extensive sales network, locked-in customer group, and through cost advantages stemming from scale and its well placed operating network.

The recovery in the financial services sector should bode well for investors. Regulatory focus on greater and more sophisticated risk management practices will also support sales of DNB products. Long-term we think that its systems will become integral in developing countries, most notably in the area of fraud detection.

A summary of key considerations include:

• DNB holds a substantial size advantage over most competitors.
• Good financials and cash-flows to support new activities.
• Product quality is highly regarded.
• DNB has substantial market share in risk management analytics and credit scoring activities.
• The company is consistently profitable.
• Shares are trading at reasonable multiples.
• Product interest has grown internationally.
• Management has proven its commitment to building shareholder wealth through growth in earnings, dividends, and share repurchase activities.
• The firm has a relatively low level of debt.
• Customers have shown loyalty to DNB due to risks of product/service failure in their own product/service lines.

Cautionary Notes

While competitively strong, a noteworthy point of caution is that growth in credit scoring activities has not been particularly strong over the last 10 years, particularly in North America. There is also more competition--while it seems to take small firms a long time to garner much traction. Another point of concern is that banks and credit card companies will start to underweight the importance of arms-length credit scores and overweigh the importance of internally developed scores in an attempt to cut costs. This could weaken DNB's pricing power. We also must note that DNB's business operations will forever be sensitive to the business cycle.

A summary of key considerations include:

• Earnings are highly cyclical as subscription fees and volumes fall during downturns.
• Future growth in North American credit scoring activities remains uncertain.
• Some of its delivery suits are due for a refresh with added functionality for mobile devices.
• No new significant product developments in the pipeline.
• Full recovery in sales at least 2 years away.
• Continued weakness in the advertising and marketing sector are hurting sales.
• Gross margins continue to decline as pricing power diminishes.
• Shares have displayed much speculative interest over the last 9 months.

Conclusion

What we like most about DNB is its ability to satisfy a key value investing tenet. That is, it has built and has been able to sustain a strong competitive advantage. DNB's brand, enormous database, locked-in customer relationships, and size and scale represent sigificant barriers to entry for competitors. While growth for this firm has certainly slowed, it is unlikely that its competitive position will be materially displaced for many years to come.